The problem is, this isn't quite about bailing out fat cats. For one, the companies most responsible for the mess have generally gone bankrupt, been effectively nationalized, or been taken over by other companies: AIG, Lehman Brothers, Fannie and Freddie, Wamu, etc.
Second, the main issue right now is that banks are not lending to businesses. Businesses depend on credit. You need a loan to start a business. Your business draws on a line of credit to pay for its inventory before converting that to sales.
The New York Times reports that numerous small businesses are facing a credit crunch. Many have problems getting credit. Interest rates on existing lines of credit are increasing rapidly.
Although experts do not yet have hard data about how the financial turmoil of the last few weeks may hamper entrepreneurs’ access to capital, many were already having difficulties getting financing before the escalation in the credit crisis.
By now, financing options for all stages of the small-business cycle are limited. Typically, start-ups and unprofitable companies have relied on credit cards and home equity loans. As their businesses thrived, they often turned to bank credit lines. And when it was time for the next big growth spurt, they usually got a small-business loan. But all of these options are less feasible now than they were a short while ago.
For example, after a quarterly survey of senior loan officers in July, the Federal Reserve reported that 65 percent of domestic banks said they had tightened their lending standards for small-business loans over the previous three months. At the same time, 70 percent told the Fed that they were charging more for those loans.
And in an August opinion poll, two-thirds of entrepreneurs told the National Small Businesses Association that their companies had been hurt by the credit crunch. Todd McCracken, the organization’s president, said that members tended to own larger and more profitable businesses, so he thought that the credit crunch was probably having an even greater impact on America’s small businesses.
The third issue is that the Treasury is probably not going to buy these assets at a price which makes the banks whole enough that they can go back to giving lavish bonuses. If the banks sell at current market prices, which reflect the price someone might pay in a panicked fire sale, they will need to take large writedowns and raise lots of additional capital. Ben Bernanke, chief of the Federal Reserve, proposed to pay a price which reflects an investor holding the security until it matures - still less than face value, but more than market value. Once they lose the securities from their balance sheets, banks will be more able to lend money to consumers and businesses.
A recent article on Alternet sharply criticized the "bailout", which should more appropriately be termed a rescue.
I find a number of Alternet's criticisms to be off-base. I might address them in future. However, we need to resolve the credit crisis, as this NYT article points out.
The current, more serious stage of the crisis began two weeks ago today, after the collapse of Lehman Brothers and the Fed’s takeover of the American International Group. Those events created a new level of fear. Banks cut back on making loans and instead poured money into Treasury bills, which paid almost no interest but also came with almost no risk. On the loans they did make, banks demanded higher interest rates. Over the past two weeks, rates have generally continued to rise — and these rates, not the stock market, are really what you should be watching.
The current fears can certainly seem irrational. Most households and businesses are still in fine shape, after all. So why aren’t some banks stepping into the void and taking advantage of the newly high interest rates to earn some profit?
There are two chief reasons. One is fairly basic: bankers are nervous that borrowers who look solid today may not turn out to be so solid. Think back to 1930, when the American economy seemed to be weathering the storm.
The second reason is a bit more complex. Banks own a lot of long-term assets (like your mortgage) and hold a lot of short-term debt (which is cheaper than long-term debt). To pay off this debt, they need to take out short-term loans.
In the current environment, bankers are nervous that other banks might shut them out, out of fear, and stop extending that short-term credit. This, in a nutshell, brought about Monday’s collapse of Wachovia and Glitnir Bank in Iceland. To avoid their fate, other banks are hoarding capital, instead of making seemingly profitable loans. And when capital is hoarded, further bank failures become all the more likely.
The crucial point is that a modern economy can’t function when people can’t easily get credit. It takes a while for this to become obvious, since most companies and households don’t take out big new loans every day. But it will eventually become obvious, and painfully so. Already, a lack of car loans has caused vehicle sales to fall further.
The rescue plan is no guarantee. However, doing nothing isn't an option either. The U.S. did nothing in the Great Depression, which is why that turned out so monumentally badly. Japan responded very slowly to its crisis in the 1990s, and the 90s are known as the lost decade in Japan.
We can debate some specifics. Conservative economists propose having the government capitalize the banks by buying preferred stock - that would inject capital directly into the banks. This could work, but there could be an issue of moral hazard, or of failing to punish the banks for their missteps. Liberal economists propose allowing the government to assume control of the mortgages directly and renegotiate the terms. This could destroy banks' trust in the mortgage process, making them less likely to lend in the future. It would also be a challenge to administer.
The original plan proposed by Hank Paulson seems a bit of a compromise. I don't think there's an ideal response in this situation, but I do take severe issue with the distrust on the Left of Paulson. The Alternet article seems not to distinguish him from the rest of the Bush administration. Admittedly, Bush and co are morally bankrupt and untrustworthy, and Paulson's demand for zero oversight was too much. However, the Treasury needs maximum flexibility to respond to the crisis. The oversight provisions that have recently been inserted will help. And there is no reason so far to assume that Paulson is acting in bad faith. The crisis is not manufactured, it is real. I've heard people point to the fact that somehow, Goldman Sachs (he was formerly CEO) has survived where a lot of banks have failed, and therefore his good intentions are questionable - that's nonsense, Goldman survived because its management team was sharp.
I continue to see the proposed rescue plan as a reasonable course of action, and I urge its passage.